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Tuesday, May 16, 2017

Where's my 5% pullback?

With the S&P 500 trading at the highs for the year it's a good exercise to check in on the underlying "health" of the market.

As we have discussed in multiple posts, this market looks very similar to the 2013 when the S&P trended higher all year. We've also touched on how even steadily trending markets can (and should) experience small and shallow corrections. For instance, 2013 had just one pullback greater than 5% which was a 7.5% drop that lasted throughout May and June. Other than that, there were a handful of smaller 3-5% declines along the way.

So far, it's looking as if 2017 will follow a similar path. If we look at that stats, we know that a 5% correction is due sooner rather than later. The S&P has now gone 132 trading days without a fall of at least 5%. Since the 2009 low, there have been just two other periods in which the S&P went longer in between 5% pullbacks. One of those periods was the 140-day run in the second half of 2013 after the aforementioned June bottom. It should be noted however that this streak also featured separate pullbacks of -4.8% and -4.9%. The other post-2009 stretch occurred in 2014 and lasted 155 days.

Current S&P 500

2014

2013

While the S&P 500 has enjoyed its strong uptrend, breadth and momentum have continued to lag. One breadth indicator we track looks at the % of stocks above their 10, 20, 50, and 200-day moving averages. As you can see below, all 4 indicators are declining as the S&P is making new highs. At some point this negative divergence needs to be resolved for the S&P to continue higher. If not it could be a precursor to the 5% correction everyone seems to want.

One of our favorite tools for getting a read on the sentiment and psychology of the market is the monthly fund manger survey from BAML. Below are some of this month's key takeaways:

May FMS is Goldilocks bullish; we believe this will lead to Icarus upside

FMS cash @ 4.9% too high for "big top" in markets, too early to short the "excess valuation" in stocks

The longs & shorts of May: Eurozone equities (3rd highest ever); short US stocks vs RoW most extreme since Nov'07; May sees rotation to industrials from utilities; banks, discretionary, tech most popular sectors; UK assets and energy still shunned.

.....It looks like the French elections eased some of the concern for the tail risk associated with a potential EU disintegration. This has coincided with favorable market conditions.

And now the most crowded trade for the first time in a while is long Nasdaq as the FANG stocks have led the overall market higher. This also confirms the breakdown in breadth. The general market has thrived off concentrated leadership as big cap tech seems to be keeping everything afloat. The performance chart below shows how much of an impact technology stocks are having on performance this year while financials and energy remain a drag.

There's still too much cash parked on the sidelines and this continues to be a catalyst that could drive markets higher. Meanwhile, according to fund managers, equities look the most overvalued since January of 2000. This seems to have driven them away from US stocks and into cheaper regions. Allocations to US equities remain below the long-term average while allocations to Eurozone equities surged to the highest level since March 2015 and the third highest on record.

The S&P and US stocks in general remain in a strong uptrend but worries about valuations and breadth have kept sentiment suppressed. Cash on the sidelines should provide fuel for a continuation higher but we should also expect short and shallow pullbacks along the way. If financials and energy turn around we could get a much needed boost in breadth and not be so reliant on tech stocks to hold the entire market up.

Ryan Worch is the Managing Director of Worch Capital LLC. Worch Capital LLC is the general partner of a long/short equity strategy that operates with a directional bias and while emphasizing capital preservation at all times.

About Me - Ryan Worch (Virginia Tech Grad)

Ryan Worch (Graduate of Virginia Tech - Pamplin College of Business) began his career in finance in 1999 at Newby & Company as an assistant trader and broker. Mr. Worch is a registered investment advisor in the state of Maryland. Mr. Worch graduated with a Bachelor of Science in Business from Virginia Tech in May 1999, where he majored in Finance.

Prior to starting Worch Capital, Ryan worked for Metzman Capital Ventures. He held various positions working his way up to portfolio manager. He managed an in house portfolio utilizing a growth strategy.

Ryan Worch (Virginia Tech) founded Worch Capital in 2006 where he currently focuses all of his attention. Worch Capital specializes in the management of enhanced equity and alternative investment products.
Worch Capital, LLC (“the firm”) is a Registered Investment Advisor
based in Bethesda, MD. The firm also serves as the General Partner of a
long/short equity strategy.

Ryan is married to a wonderful wife and has four amazing children. Outside of the office Ryan is an avid sports fan and enjoys playing golf anytime he can sneak away.

Disclaimer

Please see disclaimer tab for additional language. This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell and securities.